Climate 411

Why the American Power Act is Not a Corporate Give-Away

In his insightful post, Rob Stavins makes two key points regarding the allocation of emission allowances under climate legislation like that introduced last week by Senators Kerry and Lieberman.

First, Stavins addresses head-on the concerns that some progressives have toward the allocation provisions in the bill, asking in the title of his post: “Is the Kerry-Lieberman Allowance Allocation a Corporate Give-Away?”  To answer this question, Stavins carries out a careful breakdown of the allowance allocation in the Kerry-Lieberman bill.  He shows that the vast majority of emission allowances (more than 80% over the duration of the bill) — goes to energy consumers and public purposes (including deficit reduction).  That hardly sounds like a windfall to big corporations!  Indeed, if you add it up, the largest fraction of allowance value (43% in total, according to my calculations) goes to households, through an energy refund to low-income consumers, a tax credit to working families, a universal trust fund for all Americans, and allowances that are allocated to local electricity and gas utilities for the benefit of their customers.

As Stavins’s calculations illustrate, what matters most in terms of allocation is not whether the allowances are auctioned or given away for free, but who receives the value.  (For example, of the allowance value that is directed to households, about four-fifths comes as auction revenue, while the remainder is from the allowances allocated for free to local utilities.)

Even so, some progressives worry that free allocation is at odds with cutting emissions.  After all, if you give emitters something for free, doesn’t that eliminate the “price on carbon” that creates an economic incentive to cut carbon emissions?  The answer, actually, is “no.”

Here’s where Stavins’s second point comes in.  As he explains, it is a basic result of economics that even when allowances are distributed for free, they will still have a value (since they can be sold on a market). In economic terms, each time a company uses an allowance, there is an “opportunity cost” involved — the foregone profit they could have gotten from selling the allowance instead.  As a result, companies will still have a strong economic incentive to find cost-effective ways to reduce their carbon emissions — so that the economic performance of the bill is basically unaffected.  (It’s also worth pointing out that the environmental performance of the bill is also unaffected, since that is determined by the cap — not by how allowances are allocated.)

To put the same point a bit differently, the value of allowances doesn’t depend on how they are allocated.  Rather, allowances have value because they are in scarce supply — thanks to the cap on emissions.  The tighter is the cap, the greater is the scarcity, and the higher is the value of allowances, all else equal.

Of course, there are a few nuances worth noting.  First, from a strictly economic point of view, the best use of allowance value would be to use it to lower distortionary taxes on labor and capital, giving the overall economy an added boost.  However, getting such a “double dividend” requires not just auctioning the allowances, but using the revenue in a specific way to cut other taxes — something that has yet to generate significant political momentum.  In other words, acknowledging the possibility of a double dividend doesn’t undermine the main point that what matters is how the value of allowances is allocated, not simply whether allowances are auctioned or freely allocated.

Second, some ways of allocating allowances can affect incentives.  This can cut both ways.  In theory, using allowance value to reduce electricity rates can undermine incentives to conserve energy; this suggests that it would be preferable to compensate households for higher energy costs by sending them a lump-sum rebate rather than cutting their marginal price.  In other contexts, allowance allocation is deliberately designed to affect incentives.  For example, energy-intensive, trade-exposed manufacturers are given allocations that are tied to their output and to the average emissions intensity of their sector.  As research by Carolyn Fischer at Resources for the Future and others has shown, such “output-based rebates” manage to preserve the incentive to reduce emissions, while helping to keep manufacturing in this country and prevent “emissions leakage” to countries without a carbon price.

The bottom line is that the distinction between free allocation and auction makes little difference for the environmental or economic performance of the bill.  That’s a key point well worth keeping in mind in the coming debates over climate legislation.

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Blog highlights from the past few days

Climate Progress highlights Tom Friedman’s New York Times column “No Fooling Mother Nature” where Tom describes how

“There is only one meaningful response to the horrific oil spill in the Gulf of Mexico and that is for America to stop messing around when it comes to designing its energy and environmental future. The only meaningful response to this man-made disaster is a man-made energy bill that would finally put in place an American clean-energy infrastructure that would set our country on a real, long-term path to ending our addiction to oil.”

The New Republic showcases a new report by the Energy Information Administration which shows that CO2 emissions in the United States are down 10% from 2005 levels.

On E2, Kerry and Lieberman say they are set to unveil the climate bill on Wednesday.

The Financial Times poses the question that is in the back of everyone’s minds:  “If we can fix the ozone layer, why do we struggle in tackling climate change?”

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The New and Improved Climate 411

In order to better serve our readers, Climate 411 has introduced a new feature: blog highlights. The blog highlights lists the top climate stories of the moment with our comments and expert insights.

We have a team of experts who will be both regularly commenting on relevant stories and contributing original posts when possible. Please let us know what you think of our new format.

A word on our experts:

Mark Brownstein is deputy director of Environmental Defense Fund’s national energy program. Mark leads EDF’s efforts on smart grid deployment, transmission development, wholesale and retail electric market design, and the environmentally sustainable siting of both renewable and conventional utility scale generation. Prior to joining EDF, Mark was director of Enterprise Strategy for Public Service Enterprise Group (PSEG), where he worked directly with PSEG’s senior leadership in crafting and implementing the corporation’s business strategy.  Mark was also an active member of the U.S. EPA’s Clean Air Act Advisory Committee and New Jersey’s Renewable Energy Task Force. Aside from PSEG, Mark’s career includes time as an attorney in private environmental practice, a regulator with the New Jersey Department of Environmental Protection, and an aide to then-Congressman Robert G. Torricelli (D–NJ). Mark holds a J.D. from the University of Michigan Law School and a B.A. from Vassar College.

Nathaniel Keohane is Director of Economic Policy and Analysis at Environmental Defense Fund, a leading nonprofit advocacy organization based in New York.  Dr. Keohane oversees EDF’s analytical work on the economics of climate policy, and helps to develop and advocate the organization’s policy positions on global warming.  His research in environmental economics has appeared in prominent academic journals, and he is the co-author of Markets and the Environment (Island Press, 2007), and co-editor of Economics of Environmental Law (Edward Elgar, 2009).  Before coming to EDF, he was Associate Professor of Economics at the Yale School of Management.  He lives in New York City with his wife and two daughters. Dr. Keohane received his Ph.D. from Harvard University in 2001, and his B.A. from Yale College in 1993.

John Mimikakis works to develop global warming solutions within transportation, power-generation and agricultural sectors, by raising support on Capitol Hill for effective greenhouse gas emissions reduction policies. From 2001 to 2006, John was Deputy Chief of Staff for the Committee on Science in the U.S. House of Representatives where he was involved in legislation on a variety of issues, including energy, environment, space exploration and technology policy. Prior to that, John served as a legislative advisor to U.S. Congressman Sherwood Boehlert (R-NY) on environmental, energy, and agriculture issues. In 1997, John was the American Chemical Society’s Congressional Science Fellow. He holds a P.H.D. in Biochemistry from the University of Wisconsin and a B.S. from Tulane University.

Gernot Wagner is an economist in the Climate and Air Program. He focuses on carbon finance and works on developing and applying economically sound climate policy in the U.S. and internationally. Prior to EDF, he wrote for the editorial board of the Financial Times and worked at the Boston Consulting Group. Gernot holds a Ph.D. in Political Economy and Government from Harvard and an M.A. in Economics from Stanford.

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Comments on yesterday’s top blogs

On E2, Nike, eBay and others are asking Senators to “get stalled climate and energy legislation back on track.”

Reuters reports that the U.S. Environmental Protection Agency will start analyzing the comprehensive climate and clean energy bill. “The EPA analysis is an important step in the legislative process.” “We are sending the bill to be modeled now with Lindsey Graham’s consent,” Senator Kerry told reporters.

Green Inc. focuses on a new EPA report released yesterday called “Climate Change Indicators in the United States.”  The report is full of interesting data points and graphics including:

  • “The portion of North America covered by snow has generally decreased since 1972, although there has been much year-to-year variability. Snow covered an average of 3.18 million square miles of North America during the years 2000 to 2008, compared with 3.43 million square miles during the 1970s.”
  • “In the United States, greenhouse gas emissions caused by human activities increased by 14 percent from 1990 to 2008.”

Gernot Wagner, EDF economist notes:

“The EPA report is a terrific reminder of the fact that climate change is not some distant phenomenon our grand kids may or may not experience. We can already see some of the direct effects all around us. It’s also good reminder of the certainties among the sea of uncertainties surrounding climate change. We don’t know all the details, but the general direction has become increasingly clear. And the parts we don’t know are even scarier.”

Graph from EPA report Climate Change Indicators in the United States

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Highlights from top blogs and news stories in the last few days

The Wonk Room draws attention to a new report that shows how climate legislation will boost the economy. “This CCS analysis finds that instead of slowing the economy, household wealth and jobs will grow faster in a green economy.

Marc Gunther explores the potential of the growing wind power industry and how innovative companies are working to “capture high-altitude wind energy and turn it into electricity for off-the-grid users. Potential customers include the U.S. military, chic eco-resorts in remote locations and poor people in the global south in desperate need of power.”

The Washington Post has an editorial stressing the importance of keeping the climate bill on the Senate agenda this year. The editorial board reminds us that “every year Congress waits to legislate, adequately curbing emissions will get harder and more expensive.”

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A low carbon economy: the gift that keeps on giving

A Practical Guide To A Prosperous, Low Carbon Europe is the latest McKinsey study to show how it is eminently affordable to achieve the transition to a low-carbon world. The headline on a post by Financial Times climate über-scribe Fiona Harvey puts it best: “Europe’s energy in 2050: Cutting CO2 by 80% no more expensive than business as usual.”

How is that possible?

Initial capital expenditures are higher for renewable energy but operational cost savings along the way make up the difference. It’s the gift that keeps on giving.

To be sure, there are some very clear obstacles. The old economists’ mantra applies here as well: if it’s so cheap, why aren’t we doing it already? Well, we ought to be. The obstacles are largely political, driven by vested interests. If you are just now building a new coal plant and haven’t put much thought into carbon capture and storage technology, you may be less inclined to cheer than your neighbor investing in wind and solar.

McKinsey isn’t saying that everyone wins in this new world. The ones who see the future and act accordingly do. Most importantly, society and the planet win as well.

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